Trading and investing in stocks is quite simple in theory. Buy good stocks, manage your position, and then take your profits and move on.
Market participants tend to be pretty good at buying and holding but they do a lousy job of selling.
It isn't difficult to understand why there isn't much focus on selling. Finding and holding good stocks is the fun part of investing. Everyone enjoys talking about the great stocks that are going to make them rich. Few people want to think about how they need to sell their poor picks and give up on a longer-term winner.
Like most things in life, it is the hard or unpleasant tasks that will determine success more than anything else. Selling is the necessary evil that if we address effectively will have an outsized impact on our results.
Just because you sold a stock at a lower price yesterday doesn't mean you can't rebuy it today.
Because selling is not a decision that is approached in a systematic way the decisions tend to be more emotional. We spend the majority of our time focusing on the next great trade and when we have to deal with selling we make emotional decisions and quickly move on.
A recent academic study entitled "Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors", written by researchers from the University of Chicago, Carnegie Mellon, and MIT, compared buying decisions with the selling decisions of institutional investors.
The authors found that, on average, fund managers would produce better returns if they simply sold stocks in their portfolio at random. "We document a striking pattern: while the investors display clear skill in buying, their selling decisions underperform substantially."
That is a shocking conclusion. Professional money managers add no value to the decision to sell? They might as well just flip a coin or use astrology when making the decision to dump a stock?
The study concluded that the main reason for this is that managers tend to sell when they are forced to due to market conditions. They do not have a systematic approach to selling but generally make the decisions only when they have no choice and base these decisions on emotional factors.
The first stocks that most managers sell are those that have made the biggest moves in either direction. They sell their big losers or their big gainers at a 50% higher rate than other stocks since those are the stocks that evoke the strongest emotional responses.
However, when portfolio managers focused on fundamentals and company-specific information, they were able to improve their selling decisions substantially. When selling to simply raise cash or reduce market exposure the decisions were suboptimal.
This past week we saw a very sharp rotation action as the market tried to anticipate the impact of a Covid vaccine. This is the sort of selling that tends to be based on poor decisions because it is primarily selling to raise cash and isn't necessarily based on the merits of the individual stocks.
Important Lessons
There are some important lessons for individual traders and investors in this study:
1. Have a plan that specifically addresses selling. This is by far the most powerful action to take but there is a strong inclination to not think about selling until we are forced to. Rather than systematically dealing with the big swings that are inevitable, we react emotionally and strategy goes out the window. Panic selling isn't always a mistake but it often leads to very poor timing. Make sure your selling is based on logic rather than emotions.
2. Be proactive about selling. Many market players try to avoid the selling decision. They view it as a monumental choice rather than something that can be quickly and easily reversed. Just because you sold a stock at a lower price yesterday doesn't mean you can't rebuy it today. Even though selling is very easy to do and to undo there is a strong emotional resistance to it for various reasons. Overcoming this view of selling will help your trading more than anything else.
3. To produce better returns, focus more energy on selling. Buying is the easy part of a trade. It is managing the trade and deciding when to reduce positions that impact results far more than anything else. Focus on how to use selling to aid in positioning. It is a powerful strategic tool that can help you enhance a bullish trade but allow you to time when you want to be more aggressive. I constantly buy and sell a position as I wait for it to set up. Even though I'm convinced the stock will work over a period of time, I will cut it back during a low period so I can be even more aggressive when the time is right.
4. Substantially reducing positions on a random basis can be a helpful way to reset your emotions and the way you view the market. It is quite helpful to start with a clean slate periodically as it will alter your perception of the market substantially. It is always surprising how your view of the market will shift when you aren't wrestling with stocks that aren't cooperating.
Buying a new stock with high expectations is the fun part of trading but it is the work of effectively selling a stock that will determine our level of success.
"selling" - Google News
November 14, 2020 at 10:00PM
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The Art and Psychology of Selling Stocks - RealMoney
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